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Roth retirement accounts were established by the Taxpayer Relief Act of 1997 to give taxpayers an additional option when it comes to their retirement accounts. This act ushered in the Roth IRA and along with it the rules that make it unique.
To be a Roth IRA, the account must be designated as a Roth IRA when it is set up.
Unlike a traditional IRA, IRS rules dictate that you cannot deduct contributions made to a Roth IRA. But, if you satisfy the requirements, qualified distributions (see what determines a qualified distribution further down) are tax free. This tax-free withdrawal status is the element that distinguishes Roth accounts from all others. In a nutshell, contributions are not deductible, and withdrawals are not taxable.
Roth IRA Contribution Limits
For starters, Roth IRA contributions may be made to a Roth IRA at any age. This is opposed to a traditional IRA where contributions must end at the age of 70½. The primary requirement is that there is some sort of compensation exists for the Roth account-owner (See definition of compensation below.)
Roth IRA laws allow an annual Roth IRA maximum contribution amount of $5,000 for 2009 and 2010. The Roth catchup contribution maximum adds an additional $1,000 for 2009 and 2010, as well. So, for taxpayers 50 years old and older, the maximum Roth IRA contribution totals $6,000. For years 2011 and beyond Roth IRA maximum contribution amounts will be adjusted annually for inflation.
However, folks who make too much money may be penalized in terms of their maximum contributions. These maximum contributions will adjust downward if the taxpayer’s income is beyond the certain maximum thresholds.
For 2009, your Roth IRA contribution limit is reduced if your filing status is:
Roth IRA Eligibility
Current laws state that as long as an individual has compensation, he/she may contribute to a Roth IRA, regardless of age. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services.
It also includes commissions, self-employment income, nontaxable combat pay, and taxable alimony and separate maintenance payments. Compensation does NOT include social security income, interest, dividends, and rental income, pension income, annuity income, or capital gains.
Roth IRA Withdrawals
Owners of Roth IRA accounts may leave amounts in their Roth IRA’s as long as they live. In other words, no required minimum distributions are required. This is a feature available to Roth account-owners that is not available to traditional IRA account-owners. (Traditional IRA rules state that withdrawals MUST be taken by the account owner when that account owner turns 70½).
Roth IRA rules state that there are two basic types of withdrawals from Roth IRA’s, qualified withdrawals and early withdrawals. Below is a handy flowchart copied from the IRS.gov website that may help you in determining the difference.
Keep in mind as you navigate through the flowchart that there are essentially two types of funds found within your Roth IRA. There are amounts that are contributions and there are amounts that are earnings on those contributions. Distributions of contributions are NEVER taxable. They may be withdrawn at any time. The earnings, however, may be taxable. View the following table to find out.
Roth IRA rules can be very complex, and there are many regulations for Roth IRA’s that are not listed here. Please consult a CPA or qualified financial advisor for assistance.